Real Estate Markets

1
Real Estate Markets

• Real Estate 310
• Principles of Real Estate
• Dr. Longhofer

2
The Value of Real Estate

• The next section of the course all revolves
  around a fundamental question
• What gives real estate value?
• A simple answer is that real estate is worth as
  much as someone is willing to pay for it
• How much will people pay for real estate?
• Answering this question requires understanding
  the basic structure of real estate markets

3
Real Estate Markets

• To understand how real estate values are
  determined, it is important to recognize that
  real estate transactions actually occur in two
  distinct but interrelated markets
• In real estate space markets households and
  businesses buy and lease land and buildings in
  which they will live and work
• In real estate asset markets, investors buy and
  sell the rights to future cash flows that real
  estate will generate from the users in the space
  market
• Rents and prices for real estate are influenced
  by factors in both of these markets

4
Real Estate Space Markets

• There are a number of fundamental physical and
  economic characteristics of real estate that
  cause real estate space markets to differ from
  most other product markets
• These characteristics ultimately affect how
  existing space is used and whether new space is
  developed
• By far the most important characteristic of real
  estate is its fixed location
• Most every important characteristic of real
  estate derives from its fixed location
• As a result, all real estate markets are local

5
Real Estate Space Markets

• Because real estate cannot be moved, each parcel
  of real estate is unique
• Only one piece of land occupies the confluence of
  the Big and Little Arkansas Rivers
• A commercial office building in downtown Wichita
  is different from an identical building in
  downtown Manhattan
• As a result, real estate in a particular area for
  a particular use is scarce despite an abundance
  of land
• In addition, searching for real estate and
  gathering information about it is costly

6
Real Estate Space Markets

• Finally, the fixed location of real estate also
  means that land uses are interdependent
• Spillover effects are common in real estate
• These characteristics imply that it is misleading
  to talk about a single real estate space market
• Instead, space markets are segmented by
• Geographic location
• Property type
• Use of the property or quality within a type

7
Commercial Office Markets

• Class A office buildings command the highest
  rents because of high quality, excellent
  amenities, and prestigious tenants and location

8
Commercial Office Markets

• Class B office buildings are generally
  high-quality buildings that dont have certain
  amenities or otherwise lack the wow factor

9
Commercial Office Markets

• Class C buildings still offer cost-effective,
  usable space, but may have significant functional
  obsolescence or be in less-desirable locations
• Class D buildings are typically poorly maintained
  buildings, lack basic functionality, or are in
  very undesirable locations

10
Retail Space Markets

• Freestanding retail stores are single tenant
  buildings
• Category killer stores like Wal-Mart and Home
  Depot are frequently structured as freestanding
  retail buildings
• Major shopping centers often have freestanding
  retail stores located on pad sites on the
  periphery of the lot
• Specialty shopping centers are characterized by a
  dominant image or theme
• Old Town
• Newton Outlet Mall

11
Retail Space Markets

• Neighborhood centers are generally small, strip
  centers that serve a close-by resident population
  (5- to 10-minute drive)
• Often anchored by a large grocery chain or
  drugstore

12
Retail Space Markets

• Community centers are essentially larger versions
  of neighborhood centers that serve a larger
  market area (10- to 15-minute drive)

13
Retail Space Markets

• Regional and super-regional centers are large,
  often enclosed, centers with one or more major
  department stores as anchor tenants

14
Industrial Space Markets

• Industrial properties include
• Warehouses and distribution
• Light manufacturing and flex space
• Heavy, specialized factories

15
Residential Space Markets

• Single-family residential may be either
  owner-occupied or renter-occupied

16
Residential Space Markets

• Similarly, multi-family residential properties
  include apartments, condominiums, and coops

17
Classical Model ofSupply and Demand

• Perfect markets are characterized by
• Many buyers and sellers, each without power to
  affect prices unilaterally
• All market participants have complete information
  about the good or service being traded and the
  condition of the market
• The products traded are homogeneous
• Nothing prevents producers and purchasers of the
  good or service from entering and exiting the
  market
• There are no transaction costs
• In perfectly functioning markets, prices of goods
  and services adjust so that the quantity supplied
  just equals the quantity demanded

18
Classical Model ofSupply and Demand
19
Supply and Demand inReal Estate Space Markets

• Are real estate markets perfect?

• Many buyers and sellers, each without power to
  affect prices unilaterally

???

• All market participants have complete information
  about the good or service being traded and the
  condition of the market

No

• Nothing prevents producers and purchasers of the
  good or service from entering and exiting the
  market

• The products traded are homogeneous

No
No

• There are no transaction costs

No

• Real estate markets are imperfect, so prices will
  not always adjust to ensure that markets clear

20
Supply and Demand inReal Estate Space Markets
21
Market Response toan Increase in Demand

• Intensity of use of existing properties will
  increase, lowering vacancy rates
• Prices and rents of existing properties will rise
• If the change is perceived as long term or
  permanent, new development and conversion of
  property from other uses will increase the supply

22
Business Location Decisions

• What factors do retail users consider when
  deciding where to locate their businesses?

23
Business Location Decisions

• What factors do commercial office users consider
  when deciding where to locate their businesses?

24
Business Location Decisions

• What factors do industrial firms consider when
  deciding where to locate their businesses?

25
Real Estate Asset Markets

• Individuals and institutions often acquire real
  estate because of the cash flows it generates,
  not because they want to occupy the space
• Investment opportunities in real estate include
  income properties, REITs, mortgage loans, and
  mortgage-backed securities
• As an investment, real estate must compete with
  other capital market assets
• Real estate is attractive as an investment if, on
  a risk-adjusted basis, its expected return is
  greater than what the investor could earn
  elsewhere

26
Integrating Real Estate Space and Asset Markets

• How do space and asset markets tie together?

Demand
Supply
Economic Conditions
Prices/Rents/Occupancy
Development Industry
Capital Markets
Values
Returns
Demand
Supply